For the uninitiated private equity is a minefield of jargon, high risks and maverick investors living fast on someone else's money. This lack of understanding, fear of the unknown, alongside
Private equity fills a gap in business financing, operating at a range of risk and investment levels. And in recent months a number of factors have fallen into place, signaling a turning point for the local private equity industry.
There is previously unseen confidence in a region backed by impressive macroeconomic fundamentals. A young population of future consumers gives confidence to investors planning long-term FDI. The projected growth in the region's consumption has naturally fed into long-term savings, both as assets grow and the emerging middle class put their retirements into pensions and not children: assets under management in pension funds have grown at a compound annual growth rate of 18 per cent, and now stand at around Sh700 billion.
Today, businesses continue to chart rapid growth through security issues, and intermittent political instability. The NSE's biggest companies are growing at 20-30 per cent per year, while inflation and the shilling remain steady, leading interest rates to fall as foreign investors turn away from slowing BRICS economies.
Private equity looks set to ride on the back of this confidence. Understanding how PE can harness the stable long-term savings of pension funds will give a boost to the region's businesses, through the business model's hands-on approach to investment, and the high returns it can generate for local savers.
The concept of private equity is simple. A team of partners, or fund managers, jump go out, powerpoints in hand, and talk to investment trusts, pension funds and development finance institutions and persuade them to invest in the PE fund.
Funds sell themselves on the expertise of their personnel and the doors they open to particular sectors or international markets. Beyond the CV, it is, as one PE manager called it, "all smokes and mirrors". Like any investment it's about confidence and trust - the difference with PE is that even the managers don't know where the money's going.
Once the fund's built up, the fund will start to consider investment opportunities, researching firms and sectors through the process of 'due diligence'. Money can be drawn from the investors' commitments as and when it's needed, meaning that often little more than 40 per cent of the committed investment is in play at any one time. Once equity is bought in a firm, a partnership is formed enabling the fund management team to help the company grow until the fund 'exits', selling its share and returning the cash proceeds to its investors.
For pension funds, the model can enable higher returns to be gained in sectors managers may not have expertise in. If you want a slice of Kenya's construction industry but don't know where to start, PE could be your in.
As for businesses, PE won't always make sense. As the owner of one SME said, "I wouldn't want to hand control to partners who might not know my industry as well as I do - that just doesn't make sense." But the involvement of PE managers can bridge knowledge gaps for businesses trying to expand beyond a family-owned model, by putting more complex management systems in place or opening up new regional markets or products. "There is a bit of a mismatch in perception", Nonnie Wanjihia, Executive Director of
The biggest problem so far has been persuading
"Does private equity make sense for our clients?", writes
Investment policy statements require asset managers to seek the approval of the
Kenyan gilts currently give a risk-free 12 per cent over ten years - considering pension managers are going to be one layer away from the investment decision, there has to be a guarantee of significantly higher returns. But with average net returns of 20-25 per cent, PE investments are competing with property and the NSE's headline stocks.
There's also a basic practical issue: trustees tend to have a three-year tenure, but PE returns only show in years 6-10 (the so-called J-curve effect). They want to leave saying that they did a good job.
Finally, regulation has historically been left behind as the private sector's cogs race ahead of the administrative barriers of government. Kenya's RBA, which regulates pension funds, is yet to distinguish PE funds from the "other" (read high risk) asset class, which also includes derivatives.
Pension funds including KPLC have voiced their wish for freedom to invest more in PE than the current 10 per cent cap allows, and Wanjihia recommends that regulators consider the Nigerian model where local pension funds are mandated to commit five per cent.
The RBA also have to sign off every PE investment, a piece of red tape that causes delays and leaves pension managers looking for investments that carry less hassle.
So how can these barriers be overcome?
Anderson's advice for PE fund managers is that they need to get beyond the pension fund managers: "You also need to meet the Boards of Trustees and consultants who design the investment policy statements. You've got to keep knocking at the door until it cracks".
Another solution is to use the experience of development finance institutions (DFIs) to co-invest with pension funds. Eyamba Nzekwu, the founding commissioner of the
There's no getting away from the fact that private equity can be a risky business. If investors dive into newly formed funds without understanding the asset class, there may be deep water on the other side of the inviting returns.
Kenya's PE industry is turning a corner, riding the back of macroeconomic prosperity and the maturity of capital markets. But the high penetration of private equity seen in the
Ascent, the Eurobond, Britam and UAP's corporate bond issues: they all show the belief that Kenya's financial sector may finally be coming of age.
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